the usual suspects rise again: economic nexus, combined reporting, market-based sourcing

State legislatures and governors continued to move in the same direction this week - economic nexus, combined reporting, and market-based sourcing. The usual suspects popped up everywhere.

1. Tennessee enacted the "Revenue Modernization Act" (HB 644 and HB 291) - implementing economic nexus (effective for tax years beginning on or after January 1, 2016), and market-based sourcing (applicable to tax years beginning on or after July 1, 2016); the bills also make changes to the affiliated intangible expense addback (applicable to tax years beginning on or after July 1, 2016) and impose a new use tax on cloud computing starting July 1, 2015.
2. Tennessee Supreme Court heard oral arguments in the alternative apportionment Vodafone case (see prior posts for details). The case may be impacted by the Revenue Modernization Act's enactment of market-based sourcing.
3. Connecticut Senate proposed mandatory combined reporting (HB 7061). General Electric and Aetna, Inc. publicly communicated their disapproval by stating they would actually consider moving their operations out of state if the bill is signed by the Governor.
4. Virginia workgroup met to discuss enacting market-based sourcing.
5. Maryland Tax Court continued to use unitary principle to establish nexus (Staples Inc. v. Comptroller).
6. California Court of Appeals held that allowing only intrastate unitary taxpayers to make a separate or combined filing election was discriminatory (Harley-Davidson, Inc. v. Franchise Tax Board).
7. New York Tax Appeals Tribunal reversed an administrative law judge's determination and decided that affiliated corporations were entitled to file on a combined basis (SunGard Capital Corp).

does state sovereignty allow states to overreach?

"Substantial nexus," "economic nexus," "physical presence nexus" - who will win?

Federalism and state sovereignty - are they in conflict or can they work in concert?

"Substantial nexus" used to mean a seller had to have a physical presence in a state before they were subject to taxation. Now, more and more states are leaning on economic nexus standards which essentially say a seller can be subject to tax simply if they have customers in a state or direct some type of activity towards the state to create or maintain a market (vague, I know). Some states have taken it a step further (to make it less vague), and have instituted "factor presence" nexus standards which simply provide 'bright-line' thresholds. Meaning, these states maintain that a seller is subject to tax in their states if the seller has a specific amount of sales, property or payroll in their state. For example, the thresholds may be $50,000 of property, $50,000 of payroll or $500,000 of sales. Some state thresholds are lower for sales, such as $350,000 in Michigan or $250,000 in Washington. Regardless of the threshold limit, factor presence nexus standards and economic nexus is the trend as states look to maintain services and their budgets while imposing tax on non-voters (out-of-state taxpayers).

This discussion regarding nexus standards and the ability of the federal government to create legislation to 'big brother' the states was the subject of the June 2, 2015 Hearing before the U.S. House Subcommittee on Regulatory Reform, Commercial and Antitrust Law. Several government officials and interested parties presented testimony either for or against the 3 pieces of federal legislation currently under review:

1. The Mobile Workforce State Income Tax Simplification Act of 2015 (HR 2315)
2. The Digital Goods and Services Tax Fairness Act of 2015 (HR 1643)
3. The Business Activity Tax Simplification Act of 2015 (HR 2584)

The title to this post insinuates that states are using economic nexus to reach (or overreach) beyond their borders and tax out of state companies based on standards that are arguably unconstitutional. Regardless of that debate and regardless of which side of the fence you stand, states do have the right to determine 'how' and 'who' they tax inside their state as long as they stay with the boundaries of the U.S. Constitution and other applicable federal laws, such as P.L. 86-272. Companies and individuals have the right to conduct business across state lines without concern that they will be subject to tax when their activities are de minimus or do not reach significant (substantial) levels. Otherwise, the burden on interstate commerce is unnecessary and misplaced.

States argue that taxpayers will avoid (evade) paying taxes if the nexus standard or threshold is too high. However, states should only be able to tax what they legally can tax. Then they should seek to adjust their rules to tax who they can tax. Consequently, avoiding taxes that taxpayers shouldn't have to pay in the first place, really isn't evasion.

The states keep wanting to change their rules so they can tax more taxpayers because the economy changes (i.e., impact of Internet, remote sellers, service companies). Fine, change your rules, just don't exceed your authority and taxpayers will comply. Taxpayers deserve clarity, and to be treated within the boundaries of the law (both federal and state), so they can function and operate effectively in what is already a multi-jurisdictional, non-uniform, complex playing field.

don't let state tax 'blind spots' wreck your company

WHAT IS A BLIND SPOT?

According to Wikipedia, a blind spot, also known as a scotoma, is an obscuration of the visual field. A particular blind spot known as the blindspot, or physiological blind spot, or punctum caecum in medical literature, is the place in the visual field that corresponds to the lack of light-detecting photoreceptor cells on the optic disc of the retina where the optic nerve passes through it. Since there are no cells to detect light on the optic disc, a part of the field of vision is not perceived. The brain fills in with surrounding detail and with information from the other eye, so the blind spot is not normally perceived.

Now, that wasn't exactly what I think of when I think of a blind spot.  I usually think of a blind spot when I am driving my car.

In that context, Wikipedia says a blind spot in a vehicle is an area around the vehicle that cannot be directly observed by the driver while at the controls, under existing circumstances. Blind spots exist in a wide range of vehicles: cars, trucks, motorboats and aircraft.

As one is driving an automobile, blind spots are the areas of the road that cannot be seen while looking forward or through either the rear-view or side mirrors. The most common are the rear quarter blind spots, areas towards the rear of the vehicle on both sides. Vehicles in the adjacent lanes of the road that fall into these blind spots may not be visible using only the car's mirrors. Rear quarter blind spots can be:

• checked by turning one's head briefly (risking rear-end collisions),
• eliminated by reducing overlap between side and rear-view mirrors, or
• reduced by installing mirrors with larger fields-of-view.

STATE TAX BLIND SPOTS

Now, what does this have to do with state taxes?  

Well, I believe most, if not all, companies have state tax blind spots.  These blind spots may include:

1. nexus (taxable presence) in states in which the business is not filing income tax returns or collecting sales tax
2. using the incorrect apportionment formula, including the wrong items or amounts in apportionment factors or using the wrong method to apportion different types of income (tangible, intangible, service, etc.)
3. including the wrong entities in a combined or consolidated state income tax return due to incorrect unitary group analysis
4. classifying business income as nonbusiness income (or vice versa)
5. misapplying P.L. 86-272 protection (i.e., business is not operating within limits of protection or business is applying P.L. 86-272 protection to the wrong type of tax)
6. misapplying sales and use tax exemptions
7. not self-assessing and remitting use tax on purchases of taxable items
8. assuming the business is selling is a nontaxable service, when it is actually selling tangible property
9. assuming the business is selling intangible property, when it is actually selling tangible property
10. not adding back related-party expenses on the business' state income tax return when required
11. adding back related-party expenses on the business' state income tax return when NOT required
12. when acquiring or merging entities, failing to perform state and local tax due diligence to uncover liabilities and determine a tax-efficient way to combine the entities (before and after the acquisition/merger)
13. failing to comply with state bulk-sale notification requirements
14. filing a separate return when a combined group return should be filed
15. allowing a FIN 48 reserve for state uncertain tax positions to grow year after year without attempting to reduce uncertainty

And the list goes on and on and on.

YOUR COMPANY / YOUR STATE TAX BLIND SPOTS

In regards to your company's state tax "blind spots," it usually depends on the stage your company is in and the size of your business.

As your business grows and changes, it is vital that your business examines its state tax "blind spots" before a "wreck" (audit assessment, nexus questionnaire, etc.) occurs.

Do you know what your state tax 'blind spots' are?

Do you need to install a warning system?

this week's top 10 developments include: nexus, alternative apportionment, amnesty, transfer pricing and more

Rulings, court cases, and proposed legislation change the landscape of multistate taxation every day. It is impossible to follow all of it. I attempt to keep you aware of the items that may have a significant impact on a broad range of taxpayers. If you are following a major issue in your state that isn't listed below, and would like me to highlight it on this blog, please contact me.

Here are my top 10 for the week:

1. Tennessee is looking to establish click-through nexus for sales tax and economic nexus for income tax. Legislation moving to Governor (HB 644).
2. South Carolina issued draft guidance on alternative apportionment methods. Open for public comments until May 14th. Conference to be held on May 21st.
3. Maryland enacts favorable Amnesty? See McDermott Will & Emery's Inside SALT post for details.
4. North Dakota enacts law to phase-in single sales factor and repeal some Multistate Tax Commission provisions (SB 2292).
5. Louisiana proposes combined reporting (HB 775).
6. Missouri General Assembly passes bill that would establish market-based sourcing for sales other than sales of tangible personal property (SB 19).  
7. Nevada Senate approves bill to broaden definition of physical presence to cause remote sellers to collect sales tax, including a click-through nexus provision (SB 382).  
8. New York enacts multiple tax law changes as part of 2015-2016 budget (AB 3009).
9. New York enacted legislation makes numerous changes to New York City's taxation of corporations (SB 4610).
10. District of Columbia's transfer pricing enforcement program and combined reporting regime - appropriate? - read McDermott Will & Emery's post for details.

If you would like assistance in determining how any of the above will impact your company or clients, please contact me. Also, please contact me if you would like LEVERAGE SALT, LLC to comment, on your behalf, on the South Carolina draft guidance on alternative apportionment methods.

can you rely on informal guidance?

Each year, Bloomberg BNA compiles a "Survey of State Tax Departments." The survey is obtained by asking specific questions from state revenue departments regarding what may be viewed as 'grey areas' of multistate taxation.

The Bloomberg BNA State Tax Blog posted about how much weight should be given to informal guidance (like the survey) from state tax departments. The post and those that were a part of the discussion referenced in the post, raised great questions and points, such as:

1. How much weight should be given to informal guidance? 
2. The states know their responses will be published, so does that add 'weight' to their response?
3. The states' responses are NOT binding law and are NOT creating law.
4. What accountability do the states have for their responses if taxpayers rely on them?
5. Are the states' responses simply the equivalent of a taxpayer calling the state to obtain guidance? (meaning, it is informal guidance that is not binding and if relied upon, could come back to haunt the taxpayer at a later time)
6. If no other guidance exists (no statute, no regulation, no case, no ruling, etc.), then the survey provides some guidance as to what the state MAY do. Thus, this is probably where the survey is the most useful. 
7. If taxpayers are looking for formal guidance, they should request a letter ruling if the state allows it.

At the end of the day, taxpayers are always trying to obtain certainty regarding their tax issues. Unfortunately, it is not possible to achieve 100% certainty when the facts are complex and the state's rules are grey. Consequently, the taxpayer and adviser generally review all binding authority (statutes, regulations, cases, etc.) and unbinding authority (informal guidance, etc.) to develop support for a tax position. This is why we have the lovely 'levels of assurance' such as the 'realistic possibility of success' (33%), 'substantial authority' (40%), or 'more likely than not' (> 50%).

Depending on the situation, taxpayers are commonly balancing risk and the amount of dollars to spend to chase down this elusive certainty.  Accordingly, taxpayers are trying to attain the most cost-effective and practical solution that reduces risk to an acceptable level. Thus, other factors (business, legal, financial) may determine how much effort is taken to support a specific tax position, resulting in some taxpayers choosing to default to paying more tax to avoid risk.

Is your business struggling to find certainty?

What process do you follow to provide your clients with certainty?

How much weight do you place on informal guidance?

How do you balance risk and the cost of obtaining certainty?

how state taxes impact businesses of ALL sizes

Are you a start-up business?  A mid-sized business? Or a Fortune 500 company?  No matter the size of company, it doesn't really matter when it comes to state and local taxes.  If your company is doing business across state lines, your business is impacted by multistate taxes.

Common questions and issues:

1. Is my company required to register to file returns and pay income taxes?
2. Is my company required to register to collect and remit sales and use taxes?
3. Property taxes?
4. What credits and incentives is my company eligible to obtain?
5. My business operates as an affiliated group of multiple entities.  Does the state require us to file separate returns or one combined return?
6. How are intercompany transactions treated?  Do we have to addback intercompany expense deductions?
7. Is my affiliated group of entities unitary?
8. Does my affiliated group of entities need a transfer pricing study?
9. Are sales of services sourced differently than sales of tangible personal property?
10. What types of sales are included in the apportionment factor?
11. How are sales determined?  Gross sales or net sales?
12. Our company sales a service and a product.  Are we required to collect sales tax?  If so, on the whole charge or part of it? 
13. Our company has foreign (non-U.S.) operations.  How does that impact our state returns?
14. Our company is a foreign based company (non-U.S.) with operations in the U.S. If we don't have a permanent establishment in the U.S., are we still required to file state income tax returns?
15. How will changing the ownership and/or organization structure of our affiliated group of companies impact our state tax filing requirements? 
16. Do we owe sales tax on the purchase of a company's business assets?  Is there a bulk sale notification requirement?
17. If our company buys the assets of another company, are there any real estate transfer taxes due?
18. When can our company remove our FIN 48 reserve for uncertain state tax positions?
19. If our company owns an interest in a partnership, does that ownership interest give our company a taxable presence in the states in which the partnership operates?
20. If our company sells assets or liquidates a division of our company, is that treated as business or nonbusiness income?